How Texas Sales and Use Taxes apply to “Cloud Computing” Services

The Texas Comptroller of Public Accounts recently explained how this state’s sales and use taxes apply to certain information technology infrastructure services provided over the Internet; in other words, to so-called “cloud computing” services. In a lengthy letter ruling dated July 31, 2012, indexed as STAR Accession No. 201207533L on the agency’s research database, the Comptroller’s Director of Tax Administration described the tax treatment of five types of services, plus certain “incidental usage fees,” provided via the Internet to customers in Texas and elsewhere by a seller referred to as “Company.” Company currently has its headquarters and offices out-of-state, some limited computer server capacity in Texas, and plans to establish a more substantial presence in this state in the form of sales offices, technology development offices or data centers. The letter ruling then describes each of the services and the usage fees in detail and concludes that all of them are taxable, both under Company’s current facts and following its planned expansion in Texas.

(1) Service A. Service A allows customers to store, retrieve, and maintain content, data, applications and software on Company’s servers. This service is commonly referred to as “dumb storage.”

(2) Service B. Company provides a scalable virtual computing environment with its Service B. Through Service B, customers can procure cloud computing resources in order to perform a variety of activities, including, but not limited to, running applications, monitoring computers and computer usage, sending electronic communications, and hosting web domains – essentially anything a server can do.

(3) Incidental usage fees. Customers’ usage of services like Service A and Service B may also generate separately stated charges. These incidental usage fees are charged when a customer’s files or other data are moved within the data center network utilized by Company that is providing the Service A or Service B and other cloud computing services, or when data is retrieved by the customer from this network. This incidental usage cannot be purchased in isolation, and is always a consequence of a customer’s active use of a different and primary service such as Service A or Service B.

(4) Service C. Service C intelligently determines where best to position data in the network utilized by Company and how best to route end user requests to access that data. Customers needing to deliver digital content (e.g., streaming audio/video) to end users utilize Service C to help them get their data to end users in the most efficient way possible, creating the lowest latency possible.

(5) Service D. Service D is a highly scalable and cost-effective bulk and transactional email-sending service for businesses and developers. Service D provides customers with usage of advanced email software and server power.

(6) Service E. Service E offers a platform for creating innovative web solutions and services based on Service E’s repository of information about the web. Developers, researchers, web site owners, and merchants can use this information for the benefit of their own web sites or services. Users can access web site traffic data, related links, contact information, and a wide variety of other data.

(Readers should note that above are highly abbreviated descriptions of the services and fees discussed in the letter ruling. Any business that currently offers or plans in the future to offer such services or to charge such fees to Texas customers should thoroughly review the details in the letter ruling.)

According to the letter ruling’s analysis, Service A, Service B and Service C are all taxable data processing services within the meaning of Texas Tax Code ann. §151.0035, with the first 20% of the charge being exempt from tax by Tax Code §151.351. The same tax treatment applies to the incidental usage fees charged in conjunction with (and as a part of) the purchase of Company’s taxable data processing services.

Service D, the email sending service, is taxable but not as data processing. It is taxable as a telecommunications service under Subsection (a) of Tax Code §151.0103 and Comptroller’s Sales and Use Tax Rule 3.344, for the reasons outlined in the letter ruling.

Service E, the information repository service, is taxable but not as data processing. It is taxable as an information service under Tax Code §151.0038 and, like data processing, the first 20% of the charge for Service E is exempt from tax by Tax Code §151.351.

The letter ruling then addresses the question of where the various services should be sourced for local sales and use tax purposes. Under the applicable facts, including the fact that Company currently has only limited in-state computing infrastructure and all orders for services are received out-of-state, there is no Texas “place of business” within the meaning of Subsect. (a)(3) of Tax Code §321.002. Consequently, local use taxes will be due based on those that apply at the place of delivery, that is, at the customer’s location. That tax treatment won’t change even if, as planned, Company establishes one or more sales offices, technology development offices or data centers in Texas, because none of those facilities will count as a Texas “place of business” for local tax purposes.

About

Alan E. Sherman is a Texas attorney Board Certified in Tax Law by the Texas Board of Legal Specialization. He received his Juris Doctor degree from Harvard Law School and his Master of Laws degree in Taxation from Georgetown University. Read More